Social Security is a really big decision that is going to affect you for the rest of your life.
But, like all government programs, it is complex, making it easy to make mistakes that keep you from getting your full benefits.
Knowing the most common mistakes people make can help you get the most out of your Social Security benefits. If you’re starting to think about your retirement, here’s what you need to know about Social Security benefits and how they should factor into your retirement planning process.
1. Filing For Benefits Too Early
Many people want to start collecting benefits as early as possible. However, people don’t realize that filing for benefits too early will permanently reduce your monthly payment.
The Social Security Administration allows you to start collecting benefits as soon as you reach 62 years of age. This is considered early as the full retirement age varies based on your birth year (as dictated by Congress). Here’s the current break down of full retirement ages:
- Born in 1949 or earlier: 65.5 years
- Born between 1950 and 1954: 66 years
- Born between 1955 and 1959: 66 years and 2 months
- Born in 1960 or later: 67 years
Claiming benefits early will reduce your monthly payout by 5/9 of one percent for each month (up to 36 months). If you claim your benefits more than 36 months early, then your benefits will be further reduced 5/12 of one percent per month. This reduction in benefits is permanent, reducing the monthly payment you’ll receive.
Another common mistake is that people keep working while collecting Social Security benefits early without understanding the consequences. When you work while collecting benefits, there is a yearly earnings limit you need to stay below to avoid reductions in your benefits.
When you collect benefits early, this earnings limit is lower. Once you exceed the limit, your total benefits are reduced by $1 for every $2 you earn over the limit. On the other hand, when benefits are claimed at full retirement age, the earnings limit is substantially higher. The penalty for exceeding this limit is less severe (reduction by $1 for every $3 earned over the limit).
While filing for benefits early can be tempting, it is often the wrong move in the long run. It will have a drastic impact on the overall total benefits you will receive.
2. Waiting to Collect Spousal Benefits
One of the many benefits of being married is having the option to collect spousal benefits. Spousal benefits entitle the recipient to receive 50% of their spouses full retirement age benefit amount.
Spousal benefits are available to currently married couples and ex-spouses if married for more than 10 years and you haven’t remarried yet. However, the important thing to realize is that spousal benefits operate differently than regular Social Security benefits.
With regular Social Security benefits, deferral can increase the total amount of benefits received, but with spousal benefits, there are no deferral credits. Unaware of this, many people wait to collect spousal benefits until 70 and end up with a lower payment than they expected.
Therefore, it can be more lucrative to simply collect spousal benefits once you reach full retirement age, especially if your spousal benefits will be more than your own benefits. However, your spouse must file for their own benefit first before you can apply for spousal benefits.
Note that there are different rules for ex-spouses. You can file for spousal benefits with ex-spouses if your ex-spouse has reached age 62, even if they haven’t filed for benefits yet.
Keep in mind that just as you will be penalized for taking your own benefits early, there are penalties (permanently lowered benefits) for collecting spousal benefits before your full retirement age, unless you are caring for a qualified child.
3. Not Planning Ahead – Especially When It Comes To Taxes
It’s common for people to put off thinking about how their Social Security benefits will be taxed in retirement. In reality, however, there are plenty of things you can do ahead of time to lower taxes paid on Social Security. But, because people fail to plan ahead, they are left to pay higher taxes than they would have with early planning.
Essentially, you want to get your income below the taxable threshold or as low as possible. The important point to note is that most of the methods for reducing the taxes owed on your Social Security benefits need time to fully reap the benefits.
One option could be to move your 401(k) or IRA to a Roth IRA years before you start collecting Social Security benefits. While you will have to pay taxes the year you convert to a Roth IRA, withdrawing money in the future from the account will be tax-free.
Working with a financial planner well-before your retirement can make sure you put yourself in the best position to minimize the taxes you will pay on your Social Security benefits. Plus, it can also potentially help you have money in different types of accounts, which would give you flexibility on where to pull that money from in retirement.
Quick Recap
In the end, we all want to make sure that we get what we deserve as it relates to Social Security, as well as the taxes that we pay on it. We certainly don’t want to make any rash decisions that we might regret later. And that’s why it’s so important to do your due diligence on Social Security before you make any big decisions.
If you want to learn more, download my free book on the 10 Steps To Getting What You Deserve: A Guide To Your Social Security And Medicare Decisions.